Money From Family Abroad in Business Books: Loan, Gift or Capital

Is money from my parents a loan, a gift or a capital contribution in my business books?

It is usually one of three things, and what the sender and the business agreed when the money moved decides which: a gift to you that you put into the business, a loan the business must repay, or payment for an ownership interest. Each is booked differently, and none of the three is sales income.

A case is not simple when the money went to the business account with no paper, a relative calls it a loan but nothing has been repaid, the business pays interest abroad, a relative wants shares or repayment, a bank or accountant asks you to explain a deposit, or gifts from several relatives add up in one year. If the money has already moved, the label for each transfer and the paper behind it are what a professional can settle with you before the books close.

Gather before deciding: each wire confirmation, who sent it and how that person is related to you, whether you and the sender are each a US citizen or resident, any message about repayment or ownership, the US-dollar amount the bank credited and its fees, and how the business is taxed (sole proprietor, partnership, S or C corporation).

What decides whether it is a loan, a gift or capital?

The facts when the money moved decide it: what the sender expected back, what was signed, and what the sender received in return. No single IRS test settles it.

Three questions settle most cases:

1. Who received the money or borrowed it, you or the business? A loan to you personally that you then put into the business leaves you owing your relative. For a corporation or partnership, the business owes you only if you lend it the money; otherwise it is your contribution. A sole proprietor, or the owner of a single-member LLC that has not elected corporate tax treatment, and the business are one taxpayer for federal income tax (IRS: LLC), so what you put in is your contribution, and the interest is business interest only when the proceeds pay business expenses (Publication 334).
2. Does the sender expect repayment, and on what terms? A date or schedule, a rate and signatures point to a loan; no terms point to a gift.
3. Does the sender get ownership or a share of profits? A sender who does looks like an owner, whatever the wire memo says.

Then look at how everyone acted afterward. Payments on the written dates and the same balance in the books each year support a loan; no payments, no interest and silence for years point the other way.

A wire's memo line is not an agreement, and calling a transfer a loan years later does not make it one. Paper signed later records what the parties agree now, not what they agreed when the money moved: it carries its real signing date, lists each earlier transfer by date and amount, and is never backdated.

The tests behind those questions:

• Gift. For gift tax, the IRS describes a gift as a transfer where full consideration, in money or money's worth, is not received in return (IRS gift tax FAQ). Money a relative expects back, or hands over for ownership, is generally not a gift.
• Loan. To deduct interest on a debt, the business must be legally liable for it, both sides must intend repayment, and they must have a true debtor-creditor relationship (Publication 334). For a corporation, the Code says the regulations may weigh factors such as a written promise to pay a fixed sum on demand or on a set date with a fixed rate of interest, and the debt-to-equity ratio (26 USC 385). That section speaks only to corporations; for a sole proprietorship or an LLC, the same questions are answered from the facts.

How is each one recorded in the books?

A gift you put in and an ownership purchase go to equity, a loan goes to a liability, and none goes to sales or other income. In every case the bank account goes up by the US dollars credited. Note the source on each deposit: business income, personal funds or loans (Publication 583).

How do I record a long-term loan from a family member?

Record the principal as a loan payable named for the relative. Keep interest owed on its own line and split each payment into principal and interest. Interest is the expense (Publication 334); repaying principal reduces the liability. For a loan with no paperwork, no interest or a forgiveness, see family loan to your business.

Is a gift or capital contribution taxable income to my business?

Generally no. Gross income does not include property acquired by gift (26 USC 102), and the giver, not the receiver, is generally responsible for any US gift tax (IRS gift tax FAQ). A giver who is neither a US citizen nor a US resident is generally subject to that tax only on property situated in the United States (26 USC 2511(a)); whether a transfer qualifies, and the rules for some former citizens (26 USC 2511(b)), are for a professional. If the tax applies and the giver does not pay, the receiver is personally liable up to the gift's value (26 USC 6324(b)). A sender abroad does not change the income-tax answer; it adds reporting, covered below. One exception falls on the recipient: a gift from a former US citizen or green card holder who is a covered expatriate can be taxed to the US person who receives it (IRS: Gifts from foreign person).

• Corporation. Contributions to a corporation's capital, whether or not from shareholders, are paid-in capital and not taxable to it (Publication 542), and it recognizes no gain or loss on money received for its stock (26 USC 1032). Whether a wire into the business account was a gift to you that you contributed, or a contribution straight from your relative, depends on the facts and the paper. Cash from someone who is not contributing as a shareholder reduces the tax basis of property the corporation buys with it within 12 months, and any excess reduces the basis of its other property (26 USC 362(c)).
• Partnership or multi-member LLC. No gain is recognized on a contribution of property for a partnership interest (26 USC 721), and the basis of a partner's interest starts with the money contributed (Publication 541).
• Loan. Money borrowed through a bona fide loan is not income (Publication 334). If the lender later cancels it, the canceled amount is generally taxable, with exceptions that include amounts canceled as gifts (Topic no. 431).

Money that is really payment for goods or services is income. Keep sales and family money apart: the books must separate business from nonbusiness receipts and taxable from nontaxable income (Publication 583).

Do I report a gift from family abroad, and over what amount?

A US person reports foreign gifts on Form 3520, Part IV, when the year's total from a nonresident alien individual or foreign estate, counting related foreign persons together, is more than $100,000 (IRS: Gifts from foreign person). The rule covers amounts you treat as a gift. A bona fide loan is not a gift, so it is not reported as one; the form's loan rules concern foreign trusts. If a lender later cancels the loan, whether the canceled amount is a gift to report is a question for a professional; see family loan to your business.

• Related givers add up. Gifts from people you know, or have reason to know, are related to each other combine, as do gifts passed through a go-between. Family includes brothers, sisters, spouse, parents, grandparents, children and grandchildren, and their spouses, so both parents count together (Instructions for Form 3520).
• Foreign means not a US person. A parent who is a US citizen or resident living abroad is a US person, so that gift is not a foreign gift (IRS: Gifts from foreign person). The same test applies to you: Part IV is for a US person who receives the gift, so a nonresident owner does not report a family gift on it.
• The recipient files. For this form a US person includes a citizen or resident, a domestic partnership and a domestic corporation (Instructions for Form 3520). Money given to you is reported by you, on a separate form from the business return. When a wire lands in the business account, a written statement of who the gift was for supports treating it as a gift to the owner.
• A nonresident owner's LLC. A single-member LLC wholly owned by one foreign person files Form 5472 when it has a reportable transaction, and contributions to the LLC are one (Instructions for Form 5472); see foreign-owned single-member LLC filing.
• Penalty. A late or incomplete report can cost 5% of the gift for each month, up to 25%, unless there is reasonable cause (Instructions for Form 3520; 26 USC 6039F).

The steps, due date, inheritances and past years are in gifts and inheritances from abroad.

What paperwork do I need for a gift, a loan or an ownership interest?

Each label needs its own document, dated when the money moves.

Can the business pay interest to a relative abroad, and is tax withheld?

Yes, the business can pay interest on a real loan, but US-source interest paid to a foreign person is generally subject to withholding, usually at 30%, unless a treaty or an exemption applies. The payer is the withholding agent and is personally liable for tax it should have withheld (Publication 515).

• Who must withhold. A withholding agent may be an individual, corporation or partnership, so a sole proprietor, corporation or partnership paying interest abroad is covered; for a single-member LLC, who acts as the withholding agent is a question for a professional. Withholding applies to foreign persons, not US persons.
• Form W-8BEN. A foreign individual lender gives the payer this form before the payment, not after. It usually stays valid until the last day of the third succeeding calendar year, counted from the year it is signed, so a long note needs a fresh one; a change in circumstances, such as the lender moving to the United States, ends it, and the lender must tell the payer within 30 days (Instructions for Form W-8BEN).
• Treaty rate. The rate depends on the lender's country and the treaty. For example, the US-China treaty caps tax on ordinary interest at 10% for a qualifying resident of China who is the beneficial owner (treaty, Article 10). The lender must give a taxpayer identification number and certify treaty residence (Publication 515).
• Exemption for registered debt (portfolio interest). Interest is exempt from the withholding when the debt is in registered form and the payer holds documentation that the lender is not a US person. Registered form means registered with the borrower and transferable only by surrender and reissue or through a book-entry system; a plain signed family note is usually not set up that way. The exemption also excludes interest set by the business's receipts or profits, and interest paid to a lender holding, directly or through family, 10% or more of a corporate borrower's voting power, or 10% or more of a partnership borrower's capital or profits (Publication 515).
• When and reporting. Withholding is due when the payment is made, and a payment can count when the lender realizes the income even if no cash moves; whether interest added to the loan balance counts is a question for a professional. The payer files Form 1042-S for each recipient, whether or not tax was withheld, and Form 1042, due March 15 of the year after payment (Publication 515). The tax itself is deposited sooner: due 15 days after month-end when the undeposited total is at least $200 but under $2,000, and earlier still once it reaches that amount (Instructions for Form 1042).
• Deduction timing. Interest owed to a related foreign person is generally deductible only when paid, even on accrual books, with exceptions in paragraph (c) of the regulation (26 CFR 1.267(a)-3). For a sole proprietor, related persons include brothers, sisters, a spouse, ancestors and lineal descendants; an uncle, aunt or cousin is not. A corporation, partnership or S corporation borrower follows its own related-party tests (26 USC 267).

A loan with no stated interest, or a low rate, brings the below-market loan rules into play, covered in the family loan guide. How they apply to a lender abroad is a question for a professional. If interest was already paid abroad with nothing withheld, see missed withholding on payments abroad.

What changes if my relative becomes an owner?

An owner who is not a US person adds filings and withholding that a gift or a loan does not, and in some entities is not allowed. What changes depends on how the business is taxed. A US citizen or resident living abroad is a US person, so the S corporation bar, Form 5472 and withholding below do not apply because of where that owner lives.

Ownership can be indirect. The regulation applies the section 318 and section 267(c) family rules (26 CFR 1.6038A-1), so a spouse, sibling, parent, grandparent, child or grandchild abroad can be treated as owning shares a US family member holds, and can count toward the foreign-ownership test while holding none; an uncle, aunt or cousin is not in that group (26 USC 267). Whether that makes a corporation foreign owned depends on the facts. The penalty for a missing Form 5472 or missing records is $25,000.

A relative who both lends and owns loses the portfolio-interest exemption once the ownership reaches the levels in the interest section above. For that test, ownership counts through family: a lender is treated as owning shares held by a spouse, child, grandchild or parent (26 USC 871(h)(3); 26 USC 318(a)), so a parent who lends to a corporation their child owns can fail it while holding no shares. Similar rules apply to a partnership's capital or profits interests (26 CFR 1.871-14(g)). See a company with a foreign co-owner, funding a US corporation from abroad and foreign partners and withholding.

How do I book a wire in foreign currency with bank fees?

Book what lands in the business account, in US dollars, and keep the sender's amount, the rate and each fee on separate lines. In general, translate a foreign-currency item at the spot rate when you receive, pay or accrue it, and the IRS accepts any posted exchange rate used consistently (IRS: exchange rates).

A note written in a foreign currency is a section 988 transaction for a business whose own currency is the dollar, so repaying it can create an exchange gain or loss (26 USC 988). See foreign-currency accounts in US books.

What records show where the money came from?

Keep the records that show the path of the money and what the parties agreed. Supporting documents back the entries in your books and on your return (Publication 583).

• The wire confirmation (sender's name, country, bank, amount, date, any message) and your bank statement showing the deposit and fees.
• The sender's address, relationship to you, and whether the sender is a US citizen or resident.
• The exchange-rate source.
• For a loan, every repayment and interest payment, plus Form W-8BEN and the Forms 1042 and 1042-S.

Keep records on property, which covers shares or a partnership interest, until the period of limitations expires for the year you dispose of it in a taxable disposition (Publication 583).

Example

These examples are illustrative and use US dollars.

A gift put into a single-member LLC

An owner who is a US citizen has parents in China, not US citizens or residents, who wire US$60,000 to her personal account as a gift, with a dated signed statement that nothing is expected back. She deposits it in her single-member LLC, which has not elected corporate tax treatment. In the books it is an owner contribution, not sales. The year's total from the parents is below the US$100,000 level, so this gift alone does not call for Form 3520.

If the parents had sent US$60,000 each, the US$120,000 total would be over the level because they are related, and Form 3520, Part IV would identify each gift above US$5,000.

The same US$60,000 as a five-year loan at 4%

The LLC signs a note with the parents: US$60,000, 4% a year paid at each year's end, five years. Assume the LLC withholds on nothing else that year.

• Year 1. The deposit is a loan payable of US$60,000, not income. Interest is US$2,400 a year. Before the first payment, the parents give Form W-8BEN. With no exemption documented, 30% of each US$2,400 payment, US$720, is withheld. If the parents are residents of China who qualify under the treaty, the cap is 10%, or US$240. Either amount is deposited within 15 days after the end of the month the interest is paid, not on March 15.
• Every year. Forms 1042 and 1042-S are due March 15 of the next year, even if a treaty rate left little or nothing to withhold. Interest the LLC owes the parents but has not paid is not deductible until paid.
• Year 5. Repaying the US$60,000 principal reduces the liability. It is not an expense, and withholding is figured on the interest. The Form W-8BEN from Year 1 has usually run out by now, so the parents give a new one before this payment.

An uncle sends US$100,000 for 30% of a corporation

An uncle in India sends US$100,000 for 30% of a Delaware corporation. It is a share purchase: the corporation books US$100,000 of stock and paid-in capital in his name, not income and not a loan. He is a foreign shareholder above the 25% level, so the corporation checks Form 5472 each year for any reportable transaction with him, such as a later loan or interest. Dividends it pays him are generally subject to withholding. If the corporation had elected S status, issuing him shares would end the election.

Different for you?

• A bank or preparer is asking what the money is, a relative wants shares or repayment later, or it moved with nothing signed: the label for each transfer, the paper to sign now and what must be reported or withheld need settling before the books close. Get bookkeeping help, and see catching up on overdue books if earlier transfers were never recorded, or family loan to your business for the no-paperwork loan rules.
• It is your own money going into your LLC: see owner contribution or loan to your LLC.
• A relative abroad will own shares or join your LLC, or your corporation borrows from one: see funding a US corporation from abroad, a company with a foreign co-owner and foreign partners and withholding, and get cross-border tax help.
• You own the business and are not a US citizen or resident: see foreign-owned single-member LLC filing or funding a US corporation from abroad, and get cross-border tax help.
• Gifts passed the Form 3520 level, or a Form 3520 was not filed: see gifts and inheritances from abroad and get cross-border tax help.
• The business paid interest or repaid a relative abroad with nothing withheld: see missed withholding on payments abroad.
• The wire arrived in a foreign-currency account, or the note is in a foreign currency: see foreign-currency accounts in US books.